Sector financial performance:

This company was grouped into breakfast cereals& snacks sector of bakery industry.

It seems that the recent sales volume of companies in this sector indicate that the demands for breakfast cereals had been weak (primarily from non-core products) and declining and the decline may be reaching its maximum and rebounding in 2018. Accompanying with the decline in volume, selling price of those products seems to have been rising. Our analysis indicates that this sector is very sensitive to price’s rising. Company will lose its market share if it significantly lags behind its peers in price reduction or promotion. However, our data also indicates that the competition did not come only from the competitors inside the category but came from alternative products of cereals because the lost market shares from one company did not directly go to another one. At the same time, demand from international market seems to keep strong and contribute most of increase for those companies in the past several years.

However, while it is very sensitive to rising price, as a mature market with stable but slowly growing demands it is not that sensitive to reduction of price. Therefore, since there is no better way to stimulate sales, companies have been focusing on productivity and management costs controlling to try to improve their margins and profits and it seems that companies have been doing well before 2017. However, increasing input costs seem to be causing upward pressure on price and hurting companies ‘profitability.  Companies have managed to improve their gross margins to average 34% (30-38%), operating margin to average 16% (14-17%), and cash flow margin to 8%.

Therefore, companies will firstly need to find the sensitivity of its products price to alternative products and competitors. As long as they find its sensitive point of price, companies’ performance may up to their brands loyalty and products’ innovation.

According our analysis, the sector’s ratios of enterprise price/adjusted EBI ranges 18-24, which present a decrease in multiples compared with 2016/17 caused by concern with consumption of cereal in future.

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Company performance:

It seems the demands for breakfast related products and snacks in US market, two of main products categories of this company, have been declining as presented in the decrease in its sales volume of those products in the past four years. The increase in other product than those two mentioned above and increase in international market seem to help offset by decreased above.

For the third quarter of fiscal 2018 compared with same period of 2017(ended 20180929)

Organic sales increased 0.4% primarily due to increase in international market offset by decrease of about 1.3% in US morning food (volume and price both down) and decrease of about 3.5% in US snacks sales.

For the first nine months of fiscal 2018 compared with same period of 2017(20180929)

Organic sales was flat primarily due to decrease of about 2% in US morning food (volume down offset by up in pricing) and decrease of about 5.5%  in US snacks sales offset by increase in other products in US market and increase in all other regions.

For fiscal 2017 compared with 2016

Organic sales decreased 2.6% primarily due to decrease of about 5% in US morning food (volume down offset by up in pricing) and decrease of about 4% in US snacks sales

This company’s organic sales (excluding impacts of foreign currency exchanges) related to its morning cereals products decreased by about 6.6%, 2% and 1.6% in the first 6 months of 2017, 2016, and 2015 respectively. The deceases are all attributable to decreases in volume. Its organic sales (excluding impacts of foreign currency exchanges) related to snacks also experienced decline (down by 3%, 1.1% and 1.6% in the first 6 months of 2017, 2016, and 2015). Again, they are all attributable to decreased volume. Reduced consumption resulted in the decrease volume of products mentioned above. The sales volumes of this company’s core cereal products, however, increased slightly during the same period of time.

Under this company’s margin expansion plan, we can see that margins indeed get improved in the past two years. We see its gross margins jumped from around 34.5% of 2015 and 2014 to about 36.5% of 2016 and 2017, which may be attributable to its improved productivity. Its operating margins jumped from 7% of 2014 to 10.5% of 2017 as a result of improved gross margins and reduced spending on SG&A. As gross margin continued to go up in 2018 (about 38%) and SG&A% was improved significantly (more than 500 base points up due to less reconstruction charges), we have seen its operating margin was lifted above 17% in 2018.

Stock price

This stock currently has an enterprise price/EBI ratio of about 18, presenting the lowest multiple in peers. Our valuation methods and analysis concluded that the market may currently be undervalued considering the likely rebounding in its traditional cereal and snacks sales.